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    Hacking the Endowment Effect

    6 minute read

    Hacking the Endowment Effect

    Loss Aversion, Scarcity, & Customer Acquisition

    Loss aversion is a human tendency to place a greater value on items that we already possess, compared to those that we stand to gain. Marketers can leverage this tendency by positioning incentives in terms of a loss instead of rewards:

    1. Give something to your users.
    2. Increase its value by making it scarce.
    3. Threaten to take it away.

     


    Understanding Loss Aversion


    understanding_loss_aversion

    “Loss aversion” is a person’s tendency to value what they already have more than what they will gain. People are far less willing to part with objects that are already in their possession than to gain new items — even if the items gained are more valuable. People are also far more willing to exhibit risk-seeking behaviors to avoid a loss. Loss aversion is easiest to understand with a few examples:

    Read next: Endowment effect (Wikipedia) and Loss aversion (Wikipedia)

    Ex: Stock Traders

    Even stock traders fall susceptible to the endowment effect. Stock traders consistently exhibit loss aversion behavior by keeping their worst performing stocks in their portfolio and selling their better performing stocks. Traders would rather “let it ride” with their poor performing stocks and take the risk that the stocks will bounce back, instead of cutting their losses on the under-performing stocks (and accepting a realized loss).

    Over the long-term, this of course means that the trader’s portfolio is increasingly populated with under-performing stocks. The UC Berkeley economist Terrance Odean discovered that the stocks traders sold outperformed stocks in their portfolio by 3.4%.

    Read next: What are the best kept secrets about investing? (Quora)

    Ex: Outbreak Physicians

    We typically assume physicians to be the most rational of professionals, yet they have proved to be just as likely to exhibit loss aversion as the rest of us muggles.

    In a study by Nobel Prize economists Tversky and Kahneman, two samples of doctors were presented with two hypothetical scenarios. In each scenario, doctors were presented with a situation regarding a hypothetical outbreak.

    Scenario A:

    The U.S. is preparing for the outbreak of an unusual Asian disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. Assume that the exact scientific estimates of the consequences of the programs are as follows: If program A is adopted, 200 people will be saved. If program B is adopted, there is a one-third probability that 600 people will be saved and a two-thirds probability that no people will be saved. Which of the two programs would you favor?
    Of the the large sample of doctors surveyed only 28% elected for the riskier program B. The large majority of doctors supported the risk-averse behavior of certainly saving 200 people.

    Scenario B:

    The U.S. is preparing for the outbreak of an unusual Asian disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. Assume that the exact scientific estimates of the consequences of the programs are as follows: If program C is adopted, 400 people will die. If program D is adopted, there is a one-third probability that nobody will die and a two-thirds probability that 600 people will die. Which of the two programs would you favor?
    The percentages were flipped, with 78% of physicians opting for the riskier behavior of program D.

    In reality both scenarios are exactly the same. Saving only 1/3 of the population is the same as losing 2/3rds, and yet — when framed in terms of a loss, doctors were significantly more willing to take a risk and overwhelmingly chose Scenario B.

     


    Scarcity and Value


    scarcity_and_value

    What have diamond mines and nightclub lines figured out long ago? That an object’s value is increased with its scarcity.

    Scarcity & Facebook Gifting Applications

    Ankur Nagpal, Facebook polluter extraordinaire, leveraged scarcity to improve engagement with his Facebook gifting applications. Ankur adjusted the CTA copy in one of his gifting applications from “Send all your Friends a Hug” to,

    “You Can Only Send 20 More Hugs Today.”

    The simple change had a small effect on the number of users that would send their friends virtual gifts, but had a dramatic affect on the engagement rate of users that were already sending gifts to their friends. Ankur says that many even started hitting the artificial limit.

    By creating an artificial scarcity of gifts, the users valued each virtual hug more than when they had an endless amount.

     


    Marketing Applications & Customer Acquisition


    marketing_applications

    So what does all of this behavioral economics have to do with marketing and customer acquisitions?

    It tells us that customers are more willing to take action to prevent a loss than to gain something, even if ownership of the thing is implicitly granted.

    It tells us that users value something more when there is less of it, and when they can’t get it back.

    So how can you engineer your application to hack user behavior? Give your users something unique. Make it valuable by making it scarce. Threaten to take it away.

     

    1) Think of Something to Give Your Users

    Choosing a way to incentivize your users is one of the most important factors to consider when it comes to “growth hacking.” You want to provide value to your users, but you also want to make sure to increase the specific KPIs you are targeting. Think of the specific value that your product or service produces, and try and replicate that. Dropbox famously realized that their currency was cloud storage space, and offered more of it as an incentive to encourage their users to refer their friends. Try and figure out your currency and offer more of that to your customers.

    Make a list of complimentary goods that your specific users would appreciate. Try and distill that down to a list of products or services that are unique — every trade-show kiosk on earth is offering an opportunity at a free iPad, but how many B2B companies are offering gift certificates to Indochino, or how many tech companies are offering a free year of Zapier or Evernote Pro. If you’re a cookie company, offer your users milk. Reach out to the members of your list and see if you can work out a custom special offer with your industry peers.

    There are plenty of incentives that you can offer your customers that fit in well with your marketing funnel. Here are just a few more suggestions:

    • Swag. Everybody loves t-shirts.
    • Tickets to your next conference. Not hosting a conference? Tickets to the next conference you plan on sponsoring or speaking at.
    • Books. Encourage your customers to consume the content that fits in best with your overall marketing strategy.

     

    2) Make it Valuable

    If you want to incentivize a specific type of behavior then it helps to offer a very specific type of incentive. If you have an e-commerce store, don’t just offer your customers any product that they can purchase on their own. Ambassadors, like early adopters, tend to be motivated by status and access. The reward can be just a token that gets them access to an elite group of their super-user peers. Consider producing a limited-edition item. If you're an ecommerce store this is relatively easy, but if you are a SaaS company then try and think of a unique feature that you can add to your product.

    • Swag. Create a custom limited-edition t-shirt, or give away one of your coveted early t-shirts from when you were still in the garage.
    • Tickets to your next conference. Don’t just give tickets away, create a special “VIP Experience” that you can offer with unique dinners, meet the speakers and more!
    • Books. Leverage your industry connections to try and get autographed or personalized copies.

     

    3) Threaten to Take It Away

    In order to take advantage of your users' loss aversion, we need to frame the incentive in terms of a loss, not a reward. The incentive isn’t a gold star that your users' will earn after completing the desired behavior. The incentive should be positioned as already belonging to the user, albeit in a risky position. If the user doesn’t complete the desired behavior in the given time frame, then they will lose it forever.

     


    Gotchas


     

    Loss aversion is a proven human tendency that savvy marketers have been tapping into since well before the tech industry. However, care should be given when incorporating such a tactic into your overall marketing strategy. Loss aversion means that a user will be more willing to take action to prevent a loss than to accept a gain, but it also means that actual losses have larger effects on user satisfaction than on gains.

    Posted in Customer Loyalty, Referral Marketing, Analytics & Measurement

    Fadi George

    Written by Fadi George

    Fadi George is the website director at Ambassador, with a special interest in SEO, digital marketing and growth hacking. He's a lover of all things NZ and tech.

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